Should You Walk Away From Your Mortgage?
Underwater, upside down, it’s just all a way to say that your house is worth less than you owe. It’s just one more term we’ve had to learn after the mortgage crisis. But when is it okay to just walk away from your mortgage?
More than 10 million households in the U.S. have underwater mortgages – that is, homes that are worth less in value that the mortgage payer owes. These homeowners often cannot take advantage of lower rates on loans or refinancing deals and their homes are likely to go into foreclosure if the mortgages aren’t kept up. In most instance homeowners are turning to the banks for help in the form of Loan Modification or Short Sales, that is asking the banks to allow the homes to be sold requiring the banks to accept a reduced pay off. Some critics say it’s morally reprehensible to walk away from the mortgage and that it’s breaking a contract and failing to live up to your responsibilities. Others say, it’s their right under the terms of their mortgage. The fact of the matter is this is never a simple calculation and in all instances alternatives to foreclosure should be explored.
That said there are in fact three groups involved here, there are those who wish to keep their homes and simply can not afford the home under the current terms however, these individuals could afford the home if the loan term were to be extended out, or their interest rates were reduced and thus their payments were reduced by a couple of hundred dollars per month. The second group are those who truly can not afford their mortgage due to a financial hardship such as; a job loss, business failure, medical (health problems) etc. and for these individuals it’s just a matter of finding an early solution to getting the home sold while doing the least damage to their credit, in almost all instances the best option for these owners is a short sale. The final group are those individuals who have good income and can in fact afford to pay their mortgage but now see their house as a bad investment and a losing bet. These individuals think that if they have to pay off their mortgage, they’re going to pay far more than the house is ever going to be worth and for them, this is really a dilemma.
Consequenses of walking away from a mortgage?
Most homeowners, or homeowners as a group, don’t walk away… that is they don’t strategically default. Yet the fact is millions of Americans who are underwater, would in fact be financially better off if they did walk away, just like Morgan Stanley recently walked away from five properties in San Francisco, five buildings which were underwater. Morgan Stanley just gave the properties back to the bank. They don’t so because of anticipatory shame and guilt and beecause of an exaggerative fear about the consequences of waking away from a mortgage.
These emotions of fear and shame and guilt are cultivated by the government, by the financial industry and, to some extent, the media. And they do this by cultivating a double standard, a standard in which Americans, average Americans are told to have a moral obligation to pay their mortgage and to meet their financial obligations, whereas corporations freely and frequently default when it’s in their financial best interest to do so.
And, in fact, these groups would be obligated to protect the interest of their shareholders and walk away from an underwater mortgage if it was a financially wise decision. My argument is that this norm asymmetry, the difference in norms between average Americans and banks leads to distributional inequalities whereby average Americans are bearing a disproportionate burden from the housing collapse.
If you divorce the decision from guilt and shame and make it purely a financial one. What homeowners need to understand is that a contract is not a moral document, it’s a legal document. And the law does not provide for punitive damages, for breach of a contract because it’s not considered to be a moral wrong.
In fact, the law encourages the efficient breach of contract… meaning people should default on a contract when it is in their economic interest to do so. And because sophisticated parties understand this, they generally decide in advance for the consequences for a default on a contract or breach of a contract. In the case of a mortgage contract, the bank is the sophisticated party, and the bank puts in the penalty. That penalty is if you default, then the bank gets the house back and that’s actually the agreement. And so, a homeowner who lets go of their house and gives it back to the bank is honoring the contract and is, in fact, doing nothing immoral. The contract provides the option for default and in fact, in a non-recourse state, the bank cannot come after an individual for deficiency judgment and their only recourse is to take back the property. For those states that are recourse states, the right to pursue homeowners for a deficiency judgment can in fact be waived as part of the short sale negotiations.
The banks consider this risk of default every time a mortgage application is taken, and they factor this risk into your loan and the rate they charge you for that loan. As such, we tell people you have a contract, the contract gives you a right to walk away and you paid for that right to walk away by paying more money at closing.
How will my credit be affected?
The financial industry benefits from an exaggerated fear about credit scores and they are highly effective in their efforts to hold most Americans hostage using this tool. You hear language like - ”it’s going to destroy your credit”, “you won’t be able to get a loan” for this or a loan for that. The fact is, foreclosure will destroy your credit, however, alternatives to foreclosure such as loan modifications and short sales will only temporarily damage your credit and assuming an individual has otherwise good credit and continues to make payments on other loan obligations, their score can recover in as little as two to three years.
The homeowner has to be willing to miss at least two payments for the most part before the banks will agree to consider a loan modification (under new guidelines this is no longer the case for FHA Loan Modification requests) or a short sale, but again these options will have significantly less impact on a homeowner’s credit.
A short sale is not reported on your credit as a foreclosure, and rather is recorded as missed payments until the sale is executed at which point it will be reported a paid or settled.
If you are currently employed employers have the right, and are actively checking the credit regularly of all employees who serve a role in sensitive positions. In many cases a foreclosure is grounds for immediate reassignment or termination. Since a short sale is not reported on a credit report it is as a result not a challenge to employment. In the case of future employment many employers are requiring credit checks on all job applicants. In most cases a foreclosure will challenge employment and is one of the most detrimental credit items an applicant can have. As stated above because a short sale is not reported on a credit report it is not a challenge to employment.
Other factors to consider
The period for eligibility of a future loan differ greatly between a homeowner who loses a home to foreclosure and a homeowner who successfully negotiates and closes a short sale.
Effective May 21, 2008 the homeowner of a primary residence who loses a home to foreclosure is ineligible for a Fannie Mae backed mortgage for a period of 5 years. With a successfully negotiated and closed short sale a homeowner will be eligible for a Fannie Mae backed mortgage after only 2 years. In a non-primary residence an investor who allows a property to go to foreclosure is ineligible for a Fannie Mae backed investment mortgage for a period of 7 years. In a successfully negotiated and closed short sale an investor will be eligible for a Fannie Mae backed investment after only 2 years.
Eligibility for a future loan with any mortgage company for a homeowner who loses a home to foreclosure will affect their future rates and will require the prospective borrower to answer YES to question C in Section VII of the stand 1003 application that asks “Have you had property foreclosed upon or given title or deed in lie thereof in the last 7 years?” There is no similar question or declaration regarding a short sale.
Almost any option is better than foreclosure
Simply stated, do everything you can before foreclosure occurs and do it as quickly as possible! Don’t sit back and keep thinking, “What can I do?” Instead, contact a specialist, that is a real estate agent who specializes in this arena before your options become more limited. Again, don’t just get any real estate agent to help you! You need an agent with significant short sale experience and one who is well versed and active in this market. They will know who to talk to, when to talk to them, and how to handle all the paperwork to get the deal done! They will help relieve some of the stress you’re going through and will explain the full range of solutions that are available. If you’re looking for a specialist in Columbus, Ohio please call me today for a confidential consultation.
The Opland Group Specializes in Real Estate Sales, Luxury Home Sales, Short Sales in; Bexley Columbus Delaware Downtown Dublin Gahanna Grandview Heights Granville Grove City Groveport Hilliard Lewis Center New Albany Pickerington Polaris Powell Upper Arlington Westerville Worthington
